Wednesday, June 27, 2007

Autocratic efficiencies.

The Chinese government is considering to reduce the 20% tax on the interest earned on savings accounts. They want to make this financial tool more attractive for the population. The money has been fleeing to the stock market which has had 130% increase in 2006 and 50% so far this year. When there is a lot of money chasing a few stocks in the market, it leads to inflated prices and general instability. That's when you start seeing irrational exuberance style outlook for the future earnings.

In the US the economists complain about the negative savings rate by the households (the overall savings rate is positive because of increased corporate profits during the last few years which offsets the drop in consumer savings). But when you look at the big picture, you see that people are not stupid or greedy; it just doesn't make sense to save money. For example, let's say you saved $100 for a year at 1.5% APY. In a year, you will have earned $1.50 interest. Because of inflation (assuming 3% annual rate), your $101.50 is now worth about $98.54 worth of dollars last year. So by keeping the money for a year, you have actually lost $1.46. But wait, there is more! You have to pay ordinary income tax on that $1.50. Assuming a 20% tax rate, your $1.50 now becomes $1.20 which makes the purchasing power of your money worth $98.25 - so in a year you lose $1.75 of purchasing power.

Removing the tax on savings accounts would not help much but it would be a way to rehabilitate the negative savings rate. But you need autocratic style of governance to take action like that. It's far more profitable for our politicians to squabble about the immigration issues and fear mongering than to actually try to resolve issues.

1 comment:

Rodrigo said...

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